On this day in two years’ time, the UK will likely have left the European Union as the Prime Minister Theresa May has today sent formal notification to the EU to trigger Article 50 of the EU treaty that starts the Brexit process. Brexit will then have taken place less than three years after the EU referendum of June 2016.
That is the most certain outcome of Brexit thus far, though that is less than 100% certain because there is the possibility of extending the two-year negotiating window if all 28 nations agree that more time is needed. It’s not to say that we don’t have more detail than before. We know that Britain will prioritise the ability to control migration. The PM believes that means that Britain will not have unfettered access to the EU Single Market. Rejecting the free movement of people also means the Norway model of being in the European Economic Association is out. Yet, there are murmurings from Switzerland, which has its own migration issues, and even reportedly from Germany that some degree of control may be possible, though perhaps not that likely. Similarly, PM May wants the UK to negotiate its own trade deals, so that excludes being part of the EU Customs Union which requires members to have a common external tariff with the rest of the world. A piecemeal approach has been deemed unlikely by European policymakers and may also violate World Trade Organisation rules too. Still, could some kind of deal be done since the UK is prioritising getting tariff-free access for its biggest manufactured goods export, cars, for instance? Minimising customs requirements at the border is another reason to seek some type of Customs Union associational membership, as the PM puts it. What about financial and other services? That will require a separate agreement since Customs Union only covers goods, so the PM will have to negotiate a free trade agreement (FTA) with the EU to determine what access the services sector will have to the European Single Market. Since services comprise nearly 4/5th of the UK economy and Britain is the world’s second largest exporter of services, this is hugely important and a complicated area since non-trade barriers like standards are more relevant than tariffs and customs arrangements. There are few FTAs that comprehensively cover services. In fact, the most advanced FTA, the EU Single Market, is undergoing continuing liberalisation of the services market, so it is likely to take some time to craft such an agreement. Finally, we also know that the British government will contemplate an implementation or transitional period after leaving the EU. But, until we know what the trade arrangements are with the European Union, which will likely take years to negotiate, what are Britain and the EU transitioning towards? That is clearly better than a “cliff edge” where current EU trade rules don’t apply on March 30, 2019. Still, what would transition itself look like? That’s another area of uncertainty. The WTO regime would apply then, which would help. But, given the gulf between the preferential access to the EU at present and what the WTO rules cover, that still leaves ambiguity. At least in terms of the WTO, there is more economic certainty. Of course, between now and then, the UK and EU have to agree to split their current quotas, etc. to establish new WTO membership terms for both sides which needs to be agreed by the WTO member countries. Even if the rest of the 160 or so WTO members don’t agree to the new terms for the UK, the WTO rules dictate that the old rules would apply which in Britain’s case will be largely the same terms anyways. It doesn’t cross the T’s or dot the I’s, but the working arrangement will offer some certainty at least. The European principle that nothing is agreed until everything is agreed means that we will unlikely see the end of economic uncertainty until March 2019 at the earliest. In one sense, less than three years from the vote to departure seems fairly quick in terms of unravelling international treaties. But, in another sense, it’s rather a long time to know where everything stands in post-Brexit Britain and in an EU that excludes the UK. The UK’s Prime Minister Theresa May has said that no deal with the EU is better than a bad one, which may force the UK to rely on the World Trade Organization (WTO)’s rules for trading. But what happens the day after Brexit is confirmed? British businesses don’t want the uncertainty of being outside the EU with potentially no trade deals. So what are the options?
Until Brexit happens, the UK has to negotiate any trade deals as part of the European Union. That will obviously change following Brexit. But it also means that the UK can't negotiate trade deals with other nations formally until it leaves the EU. So the question is: can the UK just rely on the WTO rules to buy and sell goods in the absence of any other trade deals? In theory, it could but the UK and EU need to agree on how to divide up the shared WTO “schedules” – the list of tariffs and quotas that the EU applies to other countries. This is because the UK is a member of the WTO through the union. To become a fully independent member of the WTO, the UK would have to establish its own schedules. As a member of the EU Single Market, the UK can import cars without facing any tariffs, for instance. But there will be tariffs of 10% on cars after Brexit and smaller amounts on other goods, plus a few higher rates on agriculture. There may not be an immediate economic impact, but there could be longer term ramifications the longer term for, say, car production chains. Bureaucratic issues Becoming a full WTO member presents a major challenge as the UK would need to disentangle itself from all the tariffs and quotas it has signed up to through the EU. It could take years to sort everything out and that’s before we’ve even considered free trade agreements. But trade experts have told me that it can be done, as long as the negotiators are sensible. It’s in everyone’s interests for there to be no disruption, so the UK should be looking to get on good terms with the EU and WTO. America is a good example of how to negotiate. The US has around 200 trade negotiators, which doesn’t sound like it’s many but they are incredibly efficient as they only do one or two deals at a time. Britain can learn from this by looking to agree terms with a small number of countries first and then going from there. It’s really important for the UK to rack up a few trade deals. It can then use those deals to entice other nations to come to the table. Getting the US on board would be a major move. We know that Prime Minister May and US President Donald Trump have met to discuss Britain’s relationship with America. But Trump has made it very clear that he prefers bilateral trade deals to free trade agreements. It’s really difficult to imagine Trump giving Britain a very good deal while talking about putting America’s interests first. After all, “hire American, buy American” was the mantra throughout his presidential campaign. Brexit’s impact on the UK economy Will London still be an international financial centre if there are no firm trade agreements in place after Brexit? I’ve spoken with officials in China and other emerging markets who say they’re really worried about this. But it’s really hard to dislodge a city with such financial expertise. London has been a global financial capital for a long time, even though Britain’s not the biggest economy in the world. The British government is trying to prevent efforts to entice financial services firms from London to Paris, Frankfurt or Luxembourg. This is fuelled by international banks with European headquarters expressing concern about Britain leaving the single market. British financial services providers are also worried. To diversify, Lloyd’s of London is setting up operations in Europe, while HSBC will relocate some staff to Paris when the UK leaves the EU. Striking trade deals won’t happen overnight. In the meantime, the UK would need an implementation or transitional deal with the EU after finalising Brexit to help smooth the process and avoid any disruption. I think we will see one, but what will the UK transition to if it has no free-trade deal with the EU? This is the practical question that British businesses are asking. Whatever happens, we know the only certainty about Brexit is uncertainty. However, it’s important to recognise that as the fifth biggest economy in the world, the UK is resilient. The key to maintaining that position long-term is to open up new markets after leaving the EU. Trade agreements are about opening up markets, but they’re also about reducing the frictions of cross-border trade. In other words, the gains from international trade result from, among other things, the reduction of tariffs and duties, especially in an era of global supply chains.
Once Britain leaves the European Union, these economic factors will come into play. The white paper detailing the UK exit from the EU confirms that Britain will not seek to remain in the EU single market or the customs union. The UK will try to get preferential access for certain exports like cars into the EU. But, if there are differential tariffs and duties, there will be customs checks at the border to establish which duty should apply. These frictions largely pertain to manufacturing and agricultural products, and less so to services which make up more than three-quarters of the UK economy. After Brexit, there will be a lot more customs checks at Britain’s national borders. Just under half of British exports go to the European Union. They face minimal customs procedures. The principle is known as RORO or ‘roll-on, roll-off’. After Brexit, shipments to and from the European Union will be subject to the same level of checks as non-EU trade. These include customs declarations at the border, assessing the tariff or duty to be paid, and lorries as well as inspection checks for ships and planes. Direct and indirect tariff costs The British Chambers of Commerce estimate that by 2019, owing to Brexit and the overall increase in global trade through Britain, the annual number of customs declarations will rise to 390 million per annum from 90 million. A quadrupling of the paperwork will require an IT system that can manage the additional load, as well as additional physical infrastructure to ensure that the customs checks don’t cause excessive delays for the shipments or gridlock on the roads. In a measurable way, additional customs requirements will increase the cost and frictions of trading with the UK. There are also likely to be greater trading costs associated with the fall-back position of relying on the World Trade Organisation if there is no trade deal with the EU. Under the WTO, the UK would trade under ‘most favoured nation’ status with the rest of the world. Around one-third of British exports would be zero tariff and many would have tariffs of just 2-3%. But for Britain’s biggest goods export, cars, tariffs would rise to 10% from the current zero. Others, mainly agricultural products, would be subject to higher tariffs. Tariffs are an example of trade frictions that countries seek to reduce through free trade agreements. Although most tariffs are not large in magnitude, countries around the world have sought further FTAs in addition to their WTO membership to reduce these costs of trade further. An increase in tariff rates and customs costs may well be manageable in the short term. But it adds pressure to the British government to maintain the long-term competitiveness of British goods exports by agreeing FTAs to bring those costs down. What that implies is greater competitive pressure on British exports. EU officials have stated that Britain must trigger Article 50 of the Treaty of Lisbon before a trade deal can be discussed. Being in the EU also means that Britain cannot formally negotiate trade agreements with other countries. Informal talks are taking place and groundwork has been laid in the U.S., but it still means the UK won’t have any FTAs in place when it leaves the EU. One implication is that those British products which now attract zero tariffs when exported to the 50 countries with which the EU has FTAs will see those taxes rise from zero to 'most favoured nation' levels after Brexit. Therefore, the additional friction will increase not just for exports to the EU, but also for exports to places like South Korea and Canada. WTO membership terms Friction surrounds the potential uncertainty regarding which tariffs or quotas apply once Britain has left the EU. The UK is a member of the WTO as part of the EU. It can replicate existing WTO schedules for tariffs and others by essentially crossing out EU and writing in UK for the most part in a process called rectification. But there are two areas where that is not feasible. WTO subsidies and quotas are set for the EU as a whole and not for individual nations. There are about 100 quotas for imports of mutton and the like which will need to be divided between the EU and the UK. The EU and UK then need to present the new schedules to the other more than 160 WTO members which must agree unanimously to the new WTO membership terms. To avoid confusion over which quotas or tariffs apply after Brexit, it is in the interest of both the UK and EU to agree their WTO membership terms quickly. It’s the sort of trade friction that is avoidable and suggests that the Brexit talks with the EU can’t be wholly devoid of trade negotiations. In other words, in a ‘no deal’ scenario with the EU, the UK will still need to do a deal with the EU. |